Watchdog University Articles

DEFERRAL CONSEQUENCES

“It makes U.S. jobs more expensive. We’re better off taking lots of people and moving them out of the U.S.”

Steve Ballmer CEO Microsoft

The current administration wants to end deferral of multinational taxation. Currently the U.S. has the second highest corporate tax rate in the world, next to Japan, among industrialized nations. This creates a disadvantage for U.S. companies versus foreign competitors. The average corporate tax rate for the major developed countries in the Organization for Economic Cooperation and Development in 2008 was about 27 percent, more than 10 percentage points lower than the U.S. rate.

What many companies do is set up subsidiaries in low-tax countries. When the subsidiary profits, it is taxed at the rate of the country it resides in, and does not face U.S. tax until the money is repatriated. There is currently trillions of dollars in profits sitting overseas. The knee-jerk, uneducated torches and pitchforks reaction to this is to “Get those evil corporations!” They are “unpatriotic, they send jobs overseas.”

The reality is that businesses use this loophole to gain a foothold, gain market share, and compete overseas. Company XYZ produces widgets. XYZ wants to gain market share in France. XYZ’s French competitors have a corporate tax rate of 33%; whereas the rate XYZ will pay being a U.S. corporation is 38%. This forces XYZ to charge more for its widgets putting it in a competitive disadvantage in France.

A recent study by economists Mihr Desai, James Hines, and C. Fritz Foley that was published in American Economic Review collected information on American multinationals to explore the impact of foreign investments on domestic U.S. activity. The results of their study smack the conventional mainstream wisdom upside the head. They found that “10 percent greater foreign capital investment is associated with 2.2% greater domestic investment; and that 10% greater foreign employee compensation is associated with 4% higher domestic employee compensation. Changes in foreign and domestic sales, assets, and numbers of employees are likewise positively associated; the evidence also indicates that greater foreign investment is associated with additional domestic exports and R&D spending.

The bottom line is that when U.S. companies invest abroad it helps their workers here. We live in a competitive world and business will do what is necessary to survive. If the administration does away with the deferral without a subsequent cut in the corporate tax rate, companies will move their entire operations out of the U.S. The same reason why foreign auto makers set up in Alabama, Tennessee, Mississippi and other low-tax locales over Michigan will be the same reason why companies like Microsoft, Cisco and many others might move to Ireland, India or even France.